Monthly Archives: November 2008

Bloomberg News filed a federal lawsuit on November 7, 2008, to force disclosure by the Federal Reserve, under the US Freedom of Information Act, about the lending by the Federal Reserve system to private banks. Bloomberg wants to know the identities of the borrowing banks, how much each one borrowed, and the assets the Fed has accepted as collateral for these loans by the Fed.

The request is not prima facie unreasonable. Under the 11 facilities cited in the lawsuit (which don’t include the $700 bn of the TARP, which is a Treasury programme), the Fed has extended well over $2 trillion worth of credit. Initially, most of this was secured. With the growing volume of Fed purchases of commercial paper, and given the range of options for outright purchases of private securities provided by the $800 facility announced on November 26 ($200 bn for consumer credit and $600 bn for purchases by the Fed of mortgage-backed securities and of debt issued by mortgage lenders), the Fed is now also a major unsecured creditor.

The Fed’s exposure to credit risk is likely to escalate rapidly as the Fed engages in large-scale quantitative easing, taking onto its balance sheet, either as collateral or through outright purchases, ever larger amounts of every poorer quality private securities. A trillion here, a trillion there - even in Washington DC, you are talking real money for which accountability to the Congress, the US tax payer and the wider public is essential.

Consider Treasury Secretary Paulson’s words at the September 23, 2008 hearing of the Senate Banking Committee about the need for transparency in the purchase of distressed assets (the original intent of the TARP as a fund for price discovery for toxic assets was still alive then): “We need oversight,… We need protection. We need transparency. I want it. We all want it.’‘ On September 24, 20098, Bernanke also sang the Transparency Hymn in relation to the TARP: “Transparency is a big issue,”.

Transparency is such a big issue, apparently, that it cannot be squeezed into the Fed’s procedures for managing its lending facilities. Following an initial request for this information by Bloomberg in May 2008, the Fed stonewalled, never gave a formal answer, but hinted that it could not provide the information because of a commercial confidentiality exemption clause in the Freedom of Information Act.

I have long held the view that our freedom, our civil liberties and human rights, and indeed our open society, pluralist political system and way of life are endangered more by the response of the UK and US governments to the threat posed by Al-Qaeda and other terrorist groups, than by the terrorists themselves.

A further reminder of just how assiduously the British government has been chipping away at our freedom is provided by the arrest of the opposition spokesman on immigration, Mr. Damian Green, by counter-terrorism officers, his questioning by these counter-terrorism officers for nine hours and the search of his home and office. The ‘terrorist conspiracy’ being investigated concerned Home Office leaks.

According to the BBC’s website, among the recent leaks that got Home Office knickers twisted so viciously were the following:

President-elect Barack Obama will not be short of economic advice. Little of that advice will be unanimous. The Byzantine complexity of the White House economic policy-making machine means that a range of institutions and individuals will be pushing, pulling and shoving in different directions. With a new President who knows little if anything about economic matters, the adviser who comes out on top in the internecine struggle to be the Alpha-Adviser will effectively be running US economic policy. What are the institutions and who are the people in this play? Will it be drama, tragedy, comedy or farce?

In a decentralised market economy, financial intermediation between economic agents with financial surpluses and those with financial deficits (or, more accurately, between economic agents who would like to run financial surpluses and those who would like to run financial deficits) is an essential economic activity. If this task if not performed effectively, it will still be the case that, ex-post, the sum of all realised financial surpluses equals zero, that is, realised saving equals realised investment – accounting identities are very insistent – but both are likely to be far from their optimal levels. In addition to channelling resources from financial surplus units to financial deficits units, the financial system performs, through risk trading, a significant part of the total risk sharing that takes place in a society. It also performs the portfolio management of much of the stock of financial wealth in existence.

The depth of the current crisis is such that the last two tasks of the financial system (risk trading and portfolio management) are being performed abysmally, and the first, the intermediation of financial surpluses and deficits, has effectively ceased to be fulfilled by our financial markets and banks. Financial intermediation has all but ground to a halt.

Many systemically important financial markets are closed to new issuance. Even secondary markets (for trading and pricing existing asset stocks) are badly impaired. Banks have all but stopped lending to households and to non-financial enterprises. Where banks are notionally still present as lenders, the financial terms and non-financial conditions (collateral and other covenants) are often prohibitively onerous.

We have no longer just a crisis in the financial system. We have gone even beyond the stage where there is a crisis of the financial system. The western (north-Atlantic) financial system we knew has collapsed. If I may paraphrase that great ensemble of Nobel-prize winning financial wizards, Monty Python’s Flying Circus:

“This financial system is no more! It has ceased to be! ‘It’s expired and gone to meet its maker! ‘It’s a stiff! Bereft of life, it rests in peace! If you hadn’t nailed ‘it to the tax payer’s perch it’d be pushing up the daisies! ‘Its metabolic processes are now ‘istory! ‘It’s off the twig! It’s kicked the bucket, it’s shuffled off its mortal coil, run down the curtain and joined the bleedin’ choir invisible!! THIS IS AN EX-FINANCIAL SYSTEM!!”

The paralysis of financial intermediation today means that monetary policy (cuts in the official policy rates) have become largely ineffective in stimulating demand. Such cuts now appear to have little if any effect on either the marginal cost or the availability of external funds to non-financial enterprises and households. For individual open economies, the exchange rate provides a mechanism for stealing aggregate demand from the neighbours. If most of the neighbours are also in a situation of deficient aggregate demand, this redistribution of global effective demand – which is all that changes in exchange rates accomplish – robs Peter to pay Paul and is not part of a global solution at all.

The continuing importance of liquidity policy

Central banks are doing the right thing by massively expanding their balance sheets to put as much liquidity into the economy as possible. The balance sheets of the Fed and of the Bank of England have doubled since the crisis started and the balance sheet of the Eurosystem has expanded by about 50 percent. This has been accomplished through open market operations of various kinds, through which the central banks have increased their holdings of private securities by expanding the monetary base, mainly by increasing bank reserves with the central bank and other central bank loans.

Central banks will have to continue to do this. The private financial sector has to deleverage massively, but would (with credit markets and wholesale financial markets closed for business) do so in an unnecessarily destructive way if left to its own devices. The household sectors in the US, the UK and a number of other European countries have to deleverage (start saving seriously) on a significant scale. Left to its own devices, the short-run Keynesian aggregate demand fall-out from a necessary reconstruction of household financial wealth could be disastrous. So the public sector has to leverage up (borrow) at the same time the household sector is forced to deleverage.

This process of monetisation of private sector financial instruments can continue almost indefinitely. It is restricted only by the total stock of private financial instruments outstanding and by the central bank’s willingness to add private securities with higher and higher degrees of default risk attached to them to its balance sheet.

The central bank as the handmaiden of fiscal policy

With monetary policy almost powerless and with liquidity provision also subject to strongly diminishing returns, a traditional fiscal stimulus is the only show in town that has not yet been tried.

My wife and I are the proud owners of all the common stock in a small company, created originally as a vehicle for supplying consultancy services. Because we are both US citizens, the company is registered both in the US and in the UK. Over the years since its creation, an awareness has grown inside me, that what we really own is a bank: money goes out (quite a lot) and money comes in (not quite enough). All we lack to be a proper bank is leverage and a marble atrium.

To remedy this obvious deficiency, I have decided to submit a request to the US banking regulators (cc’d to Hank Paulson) to grant bank holding company status to our enterprise. If G-Mac can aspire to this status, which gives the qualifying institution access to all the Fed troughs and to what’t left of the TARP, then so can we.

Unlike G-Mac, which provides financing for crappy, environmentally unfriendly vehicles that no-one really wants, our would-be bank holding company is a model of family values at work. Sure, we don’t make loans. But show me a bank today that does. You may wish to point out that the two principals involved have no experience running a bank. You would be correct. But what really is worse, having no relevant experience or having an extensive track record of running multi-billion enterprises into the ground? Make a choice between a definite risk and the certainty of abject and costly failure.

If we cannot get bank holding company status for our company, we will fly our (separate) private jets to Washington DC to appeal for congressional support for our business as a quintessential heartland enterprise. The very fact that we are not systemically important makes us systemically important. The reason is that if we can get money from the US government, anyone can. And if anyone can, there is no longer any reason for fear, excessive caution and pessimism. Consumers will spend again. Banks will lend again. Companies will invest again. Just give us the money.

I am in Slovenia today, talking to bankers, entrepreneurs, managers, politicians, government officials and academics. The story is the same here as in every country I have visited since mid-September 2008: the banks aren’t lending. They don’t lend to each other. They don’t lend to non-financial businesses and they don’t lend to households.

In Slovenia I have been told that the banks are both solvent and liquid. I have no way to verify the solvency claim. Based on my observations of the universal ’bankers’ Dance of the Seven Veils’ – where a deeper financial hole is revealed every time a veil is dropped – my benchmark position is that there is no such thing as a ‘stand-alone’ solvent cross-border bank in the north Atlantic area any longer. All those that keep their head above water do so because of the explicit or implicit financial support of the state, which now has effectively underwritten their balance sheet.

In an earlier post to this blog, I raised the possibility that the UK might face a triple financial crisis: a combined banking crisis, sovereign debt crisis and sterling crisis. Let me be clearer than I was before about what I mean by a financial crisis. A financial crisis is a situation where quantity rationing of would-be borrowers and would-be sellers of securities suddenly replaces normal market clearing through variations in interest rates or market prices of securities.

So a sterling crisis does not require a fixed or managed exchange rate regime for sterling. It can occur even when sterling floats, that is, when its external value is market-determined, as it is today.

To all those readers of this blog who have requested shorter, snappier, less technical and abstruse postings, the following. I write this blog for me, not for my readers. Writing things down is the only way for me to communicate effectively with myself about complex issues. By doing this writing in the form of a blog, I gain the option of taking on board the comments and criticism of those who read my scribblings and feel compelled to respond to it. I gain this benefit at the cost of having to plough through a lot of stuff that makes little or no sense, in order to uncover the few pearls hidden among the swine. There are minor vanity/ego rents to having people read what I write, and my consulting income may receive an indeterminate boost from these activities. But all that is secondary to my need to write. I don’t know something unless I have written it down.

I started this blog quite independently, at http://maverecon.blogspot.com/. I was invited by the Financial Times to move my blog to their site. Because of the likelihood of greater vanity/ego rents and the possibility of more frequent intelligent feedback through wider readership, I accepted this invitation. When the FT lose interest, I will go private again. I don’t get paid for this blog.

So no, my blogs will not get shorter, snappier, less demanding, less abstruse, complicated and confusing. My blog postings are and will be excessively lengthy, long-winded, demanding, abstruse, complicated and confusing where the problems are complicated and confusing. I make no concessions to my readers. Why should I? The readers I lose or miss as a result of writing the way I do are the readers I don’t want in the first place. They can always go to the National Enquirer, Bild or the News of the World.

With the pound sterling dropping like a stone against most other currencies and credit default swap rates on long-term UK sovereign debt beginning to edge up, this is a good time to revisit a suggestion I made earlier on a number of occasions (e.g. here, here and here), that there is a non-trivial risk of the UK becoming the next Iceland.

The risk of a triple crisis – a banking crisis, a currency crisis and a sovereign debt default crisis – is always there for countries that are afflicted with the inconsistent quartet identified by Anne Sibert and myself in our work on Iceland: (1) a small country with (2) a large internationally exposed banking sector, (3) a currency that is not a global reserve currency and (4) limited fiscal capacity.

Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.